MARC has affirmed its rating on Press Metal Berhad’s (Press Metal) outstanding RM320.5 million Redeemable Convertible Secured Loan Stocks (RCSLS) with detachable warrants at A- with a stable outlook.

The proceeds from the RCSLS issuance had been on-lent to the issuer's subsidiary, Press Metal Bintulu Sdn Bhd (PMBintulu), to part-finance the construction of an aluminium smelting plant at Samalaju Industrial Park in Bintulu, Sarawak. Revenues generated by PMBintulu’s Samalaju plant are expected to provide the cash flows to service the RCSLS. In addition to the assignment of its revenues and income, PMBintulu has also provided senior upstream guarantee and a first priority charge over its project assets for the benefit of RCSLS holders.

The affirmed rating considers the issuer's consolidated credit profile as well as the cash flow generating ability of PMBintulu. The rating reflects Press Metal’s strong market position in the domestic aluminium extrusion segment and the competitive cost structure of its aluminium smelting operations. While the group's business profile has been strengthened by its backward integration into aluminium smelting, the rapid pace of expansion of its domestic aluminium smelting operations has resulted in a highly leveraged capital structure and persistent negative free cash flow which MARC regards as moderating factors for the rating.

Press Metal's backward vertical integration into aluminium smelting operations of Press Metal Sarawak Sdn Bhd and PMBintulu in Mukah and Samalaju respectively will allow the group to improve its cost position, capture greater share of the aluminium value chain and to broaden its revenue base. It should also place the group in a better position to weather the vagaries of the business cycle. However, MARC notes that the expansion initiatives are continuing at a time when the global demand for aluminium appears to be slowing and aluminium prices are weakening. While operational risks are moderated by Press Metal's successful operating record to date with its Mukah smelting operations, the rating agency believes that if market conditions remain lackluster, this could increase the risk that PM Bintulu may underperform its financial projections.

Press Metal is currently the largest integrated aluminium player in the country. The group currently has a total domestic aluminium extrusion capacity of 40,000 metric tonnes per annum (MT/pa) and a domestic smelting capacity of 120,000 MT/pa, which will increase by another 240,000 MT/pa when its Samalaju plant becomes fully operational by early 2013. Divided into two phases with smelting capacities of 120,000MT each, construction of the first phase of the Samalaju plant has been completed with commercial operations expected to start in 4Q2012 while the construction of the second phase is on schedule with operations expected to commence in 1Q2013.

PMBintulu's base case cash flow projections assume that the subsidiary's competitive cost structure will insulate it from declines in sales volumes. Assuming 80% capacity utilisation, PMBintulu is expected to maintain covenant compliance against its minimum required debt service coverage ratio (DSCR) of 1.25 times in moderately weaker aluminium pricing scenarios. MARC observes that PMBintulu's leveraged capital structure (70:30 debt-to-equity ratio) limits the subsidiary's ability to withstand both pricing and volume pressures.

For financial year ended 2011 (FY2011), Press Metal recorded a 33.5% increase in its consolidated revenue to RM2,268.8 million following the completion of the second phase of its Mukah smelting plant, and supported by a higher average aluminium price of USD2,398/MT in FY2011 (FY2010: USD2,176/MT). The group’s operating profit margin was largely unchanged from the prior year. MARC notes that Press Metal’s smelting operation in China continued to register losses as a result of increased electricity tariff costs and pricing pressures. Press Metal showed higher revenue generation of RM525.1 million for the first quarter ended March 31, 2012 (1QFY2012) against the prior year corresponding period (1QFY2011: RM471.6 million). The revenue growth is largely attributed to external sales of the smelting output from its Mukah plant which achieved full capacity of 120,000 MT/pa in end-2011.

Free cash flow (FCF) has remained negative as a result of the group’s capital spending on PMBintulu smelter project in Sarawak (1QFY2012: -RM313.0 million, FY2011: -RM404.7 million). As at end-FY2011, the group’s debt-to-equity (DE) ratio increased to 1.61 times (FY2010: 1.47 times) due to an increase in borrowings by 39.0%, which mainly constitutes the RCSLS issuance of RM199.5 million during the year. MARC expects the group’s DE ratio to increase to 1.97 times after taking into account the additional RM350 million term loan taken in June 2012 to part-fund the construction of the second phase of the Samalaju plant.

The observed trend of increased volatility in profitability of the aluminium sector and a weaker outlook for aluminium sales volumes and prices could weigh on the group's financial profile in coming quarters. Somewhat offsetting these factors is the absence of near-term debt maturities as the first redemption of the RCSLS is due in July 2014 (10% of outstanding amount).

The rating and/or outlook could change in the event financial performance weakens and/or the cash flow generation comes under increasing pressure as a result of volume and pricing pressures.

Contacts:
Taufiq Kamal, +603-2082 2251/ taufiq@marc.com.my;
Rajan Paramesran, +603-2082 2233/ rajan@marc.com.my.